30 January 2012 6:07 PM

How the vilification of Stephen Hester could cost us billions

So, Stephen Hester isn’t going to get his 3.6 million shares in RBS after all. After a weekend of furious complaints being broadcast all over the airwaves and the potential indignity of having his own individual pay package debated in the Houses of Parliament, the RBS chief executive has decided to waive his bonus.

Now, it’s rather hard to feel sorry for someone whose basic salary is over a million pounds a year and whose overall wealth dwarves what any normal person can reasonably dream of. Stephen Hester is going to get by just fine. People that rich can ride out an economic downturn without making the really tough decisions many millions of families are having to make on stretched – and often diminishing –household budgets.

But the criticism of the Hester bonus could yet have a serious knock-on effect, making the issue of a £963,000 share issue look like chicken feed.

Firstly, those expressing horror that Stephen Hester could possibly be remunerated to the tune of around £2m have generally issued a scream rather than positing an argument.

One view seems to be that, given his role as a de facto public servant, he should not be rewarded at the sort of levels common in banks which do not have the state as a shareholder. There are a whole range of implications here. When I had the audacity to point out last week that Hester’s package was broadly comparable to that of a mediocre Premiership footballer, I was told in no uncertain terms that this was irrelevant as Manchester United, Arsenal and other clubs are not taxpayer-owned. Can we presume, therefore, that there won’t be a public furore over the size of the bonus paid to Barclays’ boss, Bob Diamond? If you own shares in Barclays, you can take a view. But you can’t do so merely as a taxpayer.

A further implication, of course, is that banks part-owned by the state will not be able to attract the same quality of staff as those working for wholly privately-owned banks. Why work for RBS for £1m, if you can do a similar job for another bank for £5m? Not only are you paid much less to work for RBS (and everyone seems to believe that Stephen Hester could earn more elsewhere), but you run a far greater risk of your name being dragged through the mud over several days of media coverage.

And here is the nub of the issue. The key task at RBS is to return the bank to some sort of fit state in order that it can be returned to the private sector. The better the condition it is in, the more money the taxpayer will eventually claw back to cover the cost of the bailouts – or just possibly, to make a profit.

An absolute fortune is at stake here. Would you be willing to put a cap on RBS remuneration – for example, a rule that no employee will be paid more than £500,000 per annum – even if you strongly suspected this would lead to the Royal Bank of Scotland losing a number of key staff and eventually being worth several billions of pounds less when it is returned to the private sector? If so, that would represent a triumph of ideology over the needs of taxpayers and the public purse.

I don’t know Stephen Hester. I have never met him. I don’t know whether he will see the job through at RBS or whether the last few days will incline him to look for a better paid, lower profile job elsewhere. If he did move on, I could hardly blame him. He would, it is widely agreed, be difficult to replace. In fact, given the mill he has been dragged through, you may very well have to pay his successor considerably more to make the role an attractive one – or to accept a far less competent replacement.

A second unhelpful argument has been to criticise bonuses in general. We are told that people are already paid a salary do to their jobs and only a truly exceptional, almost perfect record of performance should lead to any bonus being paid at all.

But why should this be the case? Put aside whatever you think the right overall salary for any given job should be, why not try and include a substantial – and flexible – percentage of this sum based on performance? The employee would get a basic salary, of course, but this would then be topped up based on a judgment as to whether they had performed moderately, fairly well, very well or sensationally. A very large percentage of such incentivised employees would probably get an annual bonus – although you’d expect very few to be given 100% of the total target they were aiming for. Stephen Hester, of course, was issued 60% of the bonus he was potentially eligible for. The implication seems to be that paying him £2m a year with no prospect of a bonus would be preferable to paying him around £1m a year with a flexible bonus of between £0 and £2m (the actual realisable value being based on the future share value of the company, of course). The public relations furore surrounding the RBS bonuses might well be expected to lead the market in this direction – higher basic salaries being paid because bonuses attract such controversial publicity.

There are practical limits to the bonus culture. Some jobs are much easier to evaluate than others. We also don’t want to embrace endless swathes of state-determined targets, which often generate perverse incentives and lead to a substantial proportion of time being spent measuring performance rather than improving it.

But performance-related pay can still play a valuable role. Wayne Rooney is paid several million pounds a year as a basic salary by Manchester United. But this doesn’t mean that his pay shouldn’t, to some degree, be set by exactly how many goals he scores, or how many matches his team wins or how many trophies Manchester United secure in a season. Or even being tagged to the number of replica shirts sold or the gate receipts at Old Trafford or the television revenue received from Sky Sports. There isn’t hysteria when Wayne Rooney claims his goal bonus or win bonus, even though he is already paid handsomely to score goals and win matches for his club. There is no reason why top bankers should be any different.

The focus on the debate about a bonus worth less than a million pounds is deflecting us from a much wider, and more important, debate about how we maximise the value of the 83% of RBS owned by the state and ensure that taxpayers never have to bail out banks again.

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MARK LITTLEWOOD

Mark Littlewood is Director General of the Institute of Economic Affairs. He was educated at Balliol College, Oxford, where he read Philosophy, Politics and Economics.

He went onto study at City University Law School. Since 1995, Mark has worked in political communications, public relations and public affairs – variously for the European Movement, the Environment Agency and the London Bus Initiative.

In 2001, he became Campaigns Director for the human rights group Liberty, leaving in 2004 to found NO2ID, the group which opposes identity cards and the database state, and became its first national co-ordinator.

From December 2004 to May 2007, Mark was Head of Media for the Liberal Democrats. In 2007, Mark co-founded Progressive Vision, a classical liberal think tank and was its Communications Director until November 2009.